We all like to think we are fully rational human beings, capable of staying in control of our emotions and making sound decisions in all areas of our lives - especially when it comes to investing. When markets are steady and moving in a upward trajectory, many of us are able to operate in a “calm, cool, and collected” fashion. However, when volatility arises and markets correct, we tend to lose that focus and revert to our subconscious behaviors. (Just think back to your mindset in November and December of 2018 and I’m sure you’ll identify with some reactionary thinking).
While there are countless behavioral finance biases that impact all investors , today we’ll focus on one that has come up in many conversations as of late - anchoring
Anchoring refers to our tendency to attach (or anchor) our thoughts to a reference point - even if that reference point may have no logical relevance to the decision at hand. Here are just a few examples of anchoring - and some suggestions on how to overcome it in and “set sail” from here on out
1.) High-water mark
I’m guessing you may know this number - the all-time high balance you observed for your investment portfolio. Perhaps you arrived at that amount in January 2018 or in early October 2018 or in recent weeks. Regardless of the exact date, you likely know the number and have evaluated your portfolio’s performance against that mark ever since. You may find yourself thinking things such as: “if I could only get back to that value” or “when I get back to that value I’ll (fill in the blank),” or “had I known what was coming, I would have moved to cash when I hit that level”
If you step back, what does that value really represent in your investing journey? Not much - it’s simply a reference point. One of many reference points during a multi-decade journey. Had markets kept advancing past that point would you be focused on that value? Likely not. Would you really have altered your whole investment approach when you reached that number (without any other information)? Again, likely not. Is it logical to compare your performance to that number? Again, no.
That number only has relevance because you have anchored to it. There’s no going back - we are sailing forward and can’t go back. Consider focusing on more relevant comparisons such as the return of your blended investment benchmark over the comparable time period and your unique return goals. How are you doing in comparison to those metrics? Pay attention to relevant data points and you may just pass by that previous anchor
2. Evaluating individual stocks
Anchoring is especially prevalent in evaluating individual stocks, especially when it comes to selling vs holding (or adding to) stocks that have fallen in value. As an example, if we pay $50 for XYZ company and it falls to $30, we become very focused on that $50 price point (we anchor to it). “I’ll sell it when it gets back to $50” or “I’ll just hold on until it gets back to break even - but I’m not buying more” We’ve anchored our assessment of that company’s fair value to the price we paid for the stock, which truly is not all that relevant.
That price you paid is what the market was willing to sell it to you for on that given day. After you buy it, that price isn’t all that relevant any longer. Instead, you should continue to do your homework and independent research and determine what you believe to be the fair value of the company (and its underlying stock). If the stock remains below the fair value by a margin that is more attractive than other alternatives, it may be worth holding - on even adding more. If the stock has exceeded your fair value estimate, perhaps it’s time to move on and find another under-valued opportunity. But to anchor to the price you paid (or even to the current trading price) won’t help you make an informed decision.
Stock markets may be the only marketplace in the world where consumers don’t like to buy as prices come down. However, with the right reference points in your sight-line (ie: your estimates of fair value, independent of price you paid or current trading prices), you will have a shopping list ready to go during the next pullback
3. Market estimates
Anchoring also comes into play in our forecasting of general market performance. Investors tend to anchor on the current level of an index as their reference point and using that, make estimates that tend to be very close to the current level. As the Dow Jones approached 27,000 in early October 2018, estimates were clustered around 28,000 - or even 30,000. And when markets corrected and started to fall, estimates were quickly revised downward, in lockstep with the actual moves in the indexes themselves.
Instead of anchoring to a current index level in determining how to allocate your capital, consider evaluating the current state of the economy and more importantly, the rate and direction of change of those elements. Where do we stand in terms of growth, inflation, interest rates, economic activity, and labor force? And are these components getting better or worse? Those are relevant data points in determining when and how to allocate your capital to various asset classes
Anchoring is an instinctual human behavior - one that we have all been guilty of from time to time. Remaining aware of these examples - and the tactics to pull up your anchors in future - will make you an even better investor going forward.
Let’s sail forward and leave those anchors behind!
Ways to overcome anchoring
*Carefully evaluate your refernece point - is it the rigth metric
*Compare to alternatives at the present moment - not the asset in the past